India Cuts Loan Tax to Spur Inflows, Signals 5.3% Budget Gap

India lowered a levy on overseas borrowing to spur capital inflows, stepping up efforts to revive a faltering economy, and signaled the budget deficit may be contained at about 5.3 percent of gross domestic product.

A tax on interest paid by local companies to lenders abroad has been cut to 5 percent from 20 percent, the Finance Ministry said. The ministry expects the fiscal gap in the year that began April 1 to exceed the 5.1 percent goal set in March by 0.2 percentage points, two officials with knowledge of the matter said, asking not to be identified as the projection isn’t public.

The rupee and stocks surged after the tax cut, which follows an increase in diesel prices to pare fuel subsidies and moves to allow more foreign investment, ending months of policy inaction. The deficit forecast is smaller than estimates by Citigroup Inc. and Crisil Ltd., Standard & Poor’s local unit, which predict the gap will widen from last year’s 5.8 percent.

“The full thrust of the government’s actions seems to be on regaining investor sentiment,” said Rupa Rege Nitsure, economist at state-owned Bank of Baroda in Mumbai. “Even though these steps are coming late in the day, what is now critical is that they don’t go back on them.”

The rupee strengthened 1.7 percent to 53.4575 per dollar as of 3:39 p.m. in Mumbai, while the BSE India Sensitive Index rose 2.2 percent. The yield on the 10-year bonds due June 2022 fell to 8.16 percent from 8.17 percent earlier.

No Reversal

The reduction in the withholding tax will be applicable for three years, effective July 1, 2012, the Finance Ministry said in a statement in New Delhi.

The government raised diesel tariffs on Sept. 14 for the first time in over a year, the same day it opened industries including retail and aviation to more overseas investment. Prime Minister Manmohan Singh is trying to avert a credit-rating downgrade and revive growth with a burst of policy changes.

The overhaul won’t be reversed, the officials said, even after the largest political ally in the ruling coalition said it would quit in protest at the steps. The 14 percent diesel-price rise, forthcoming auctions of mobile-phone permits and planned share sales by state companies should avert a wider budget gap, the officials said.

“Even after the measures announced last week, there are huge risks to the deficit from higher subsidies and a revenue shortfall due to slowing growth,” said Suvodeep Rakshit, an economist at Kotak Securities Ltd. in Mumbai. “I am not too confident about the budget estimates.”

Borrowing Program

The government must curb subsidies to avoid exceeding its 2012-2013 borrowing target of 5.69 trillion rupees ($107 billion), both the officials said. The administration will probably retain that goal at a meeting due this month to outline the borrowing schedule for the second half of the financial year, one of the officials said.

Singh is trying to trim a subsidy bill for food, fuel and fertilizer by 12 percent to 1.9 trillion rupees in the year through March 2013. The government had set a budget-deficit target of 5.1 percent of GDP for the year in the budget released in March. Citigroup predicts a shortfall of 5.9 percent and Crisil forecasts 6.2 percent.

The government intends to raise at least 350 billion rupees from an auction of mobile-phone permits and about 300 billion rupees from the sale of shares in state-owned companies, one of the officials said. An increase in diesel excise duty last week will garner 160 billion to 170 billion rupees, the official said.

The Reserve Bank of India has signaled that curbing the budget shortfall is pivotal to increasing room for interest-rate cuts to bolster economic expansion, which weakened to a nine- year low of 6.5 percent in 2011-2012.

The prime minister’s Congress party-led cabinet allowed overseas retail chains such as Wal-Mart Stores Inc. to open stores in India under last week’s revamp, triggering strikes across the nation yesterday on concern family-run stores, the backbone of the retail market, will be forced out of business.

Standard & Poor’s and Fitch Ratings reduced the outlook on India’s credit rating to negative from stable earlier this year, bringing the nation a step closer to junk status.

India lowered a levy on overseas borrowing to spur capital inflows, stepping up efforts to revive a faltering economy, and signaled the budget deficit may be contained at about 5.3 percent of gross domestic product.
A tax on interest paid by local companies to lenders...